Anit-Employee Control Fraud

By davidpetraitis, on January 19th, 2012

Bill Black has continually been on the watch for what he calls “control-frauds” which are just frauds by management of a company to hide illegal and/or greedy behavior. In a new article Anti-Employee Control Fraud in New Economic perspectives he departs from his usual target of banking to look at the recent news about Apple’s supply chain.

Businesses that pursue anti-employee behavior in developing markets can profit from this with impunity, even when it is illegal in that country. And as in the case with other ethical lapses, the fraud drives ethical players out of the market:

Anti-employee control fraud creates real economic profits for the firm and can massively increase the controlling officers’ wealth. Honest firms normally cannot compete with anti-employee control frauds, so bad ethics drives good ethics out of the markets. Companies like Apple and its counterparts create this criminogenic environment by selecting least-cost – criminal – suppliers who offer components at prices that honest firms cannot match. Effectively, they hang out a sign – only the fraudulent need apply to be suppliers. But the sign is, of course, invisible and cannot be introduced in court so Apple and its peers also get deniability. They are shocked, shocked that its suppliers are frauds that cheat their employees and put them and the public’s health at risk in order to make a few extra yuan or dong for the senior officers.

Fraudulent suppliers, therefore, have compelling incentives to locate in nations and regions in which they can commit fraud with impunity. The best way to evaluate the fraudulent CEOs’ view as to the risk of prosecution for their frauds is to observe whether they take cheap means of hiding their frauds. When the CEOs do not even bother to avoid creating a paper trail documenting their frauds one knows that they view the risk of prosecution as trivial. Nations that are corrupt, have weak rule of law, weak or non-existent unions, poor protections for workers, a reserve army of the impoverished, and have few resources devoted to prosecuting elite white-collar crime provide an ideal criminogenic environment for firms engaged in anti-employee control fraud. The ubiquitous nature of anti-employee control fraud (and tax fraud) in many nations explains why U.S. industries have been so eager to “outsource” U.S. jobs to fraud-friendly nations. Companies like Apple also discovered long ago that Americans often made poor senior managers in these nations because they objected to defrauding workers. Not a problem – there are plenty of managers from other nations that have no such ethical restraints. Foreign suppliers run by Asian managers are increasingly dominant.

Not my emphasis where Bill Black gives a slight back-handed compliment to “ethical” American managers. The behavior that he outlines in this article creates what he calls a Gresham’s dynamic against ethical players:

George Akerlof, in his famous article on markets for “lemons” (largely describing anti-customer control fraud), explained the perverse “Gresham’s” dynamic in 1970.

“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”

Prof. Black has expanded in a most useful way the idea of control fraud. He enumerates 4 types of anti-employee behavior:

Anti-employee control frauds most commonly fall in four broad, but not mutually exclusive, categories – illegal work conditions due to violation of safety rules, violation of child labor laws, failure to pay employees’ wages and benefits, and frauds based on goods and loans provided by the employer to the employee that lock the employee into quasi-slavery.

I would add one that is mostly seen in the United States, the employment of illegal immigrants at less than prevailing wages. The Gresham’s dynamic in the realm of benefits also is at work here in the US. I have heard from a number of people who say that they have been offered or accepted part-time employment at a company that pays benefits to full-time employees, but not to part timers under a certain number of hours. This legal but unethical if they hire several part timers to do a full time job, yet avoid paying benefits.